Payroll Tax Compliance: What Happens During Bankruptcy?

Posted October 12, 2016byCSS

The case of Pitts v. United States is a good reminder for all business owners that company structure and payroll taxes can come back to bite you in the proverbial posterior if you don’t pay close attention to what’s happening around you.

Pitts v. United States: Personal Liability For Company Taxes

The case of Pitts v. United States illustrates the tangled web that is woven in a general partnership that provides no legal separation between the individual and the organization. Wendy K. Pitts was a general partner in DIR Waterproofing, a company that went out of business in 2008. When DIR went under, it was not paying its payroll taxes. Notices of Federal Tax Lien were issued to each partner four years later, stated that penalties and interest had reached $110,000.

In 2012, Pitts filed for Chapter 7 bankruptcy to discharge this debt. As part of the bankruptcy, she filed an adversary proceeding against the government to discharge the federal tax liens. This was an interesting maneuver because under Chapter 7, the federal government is always one of the first creditors to receive payment when assets are liquidated. Additionally, you cannot discharge federal income tax debt unless some very high standards are met.

The courts sided with the federal government and would not allow the debt to be discharged. Pitts appealed to the district court of appeals, arguing:

A general partner is not a taxpayer with respect to payroll tax withholding liabilities of a general partnership

The IRS failed to separately assess the tax against her within the three-year statute of limitations.

Since the IRS never assessed her tax liability, she wasn’t responsible for DIR’s tax debt under federal law.

That court rejected her arguments and agreed with the bankruptcy court that the debt could not be discharged. However, Pitts was not discouraged and she appealed once again, to the US Court of Appeals for the 9th Circuit. Her attorney argued this time that since she was a general partner under state law, the federal government had to stick to remedies established by the state in order to collect its debt, rather than federal enforcement procedures.

Once again, the appeal was rejected and once again Pitts was deemed liable for the payroll tax lien on the partnership.

Why Do Payroll Taxes Matter In A Bankruptcy?

So why should anyone really care about this case, outside of ensuring your payroll taxes are paid? If you are a leader in a company set up as a general partnership, you could face the same types of trouble in the future. Remember that in general partnership there is no legal separation from the business to the general partner. While it may not be a tax lien, it could be any financial liability or lawsuit that leaves you exposed.

Company structure is critical to keeping your business afloat and keeping you and your partners solvent, but so is the right team of accounting and finance professionals. If you want to remain compliant across the board, you have to have the right people in place who can ensure that money keeps flowing, and that all of your i’s are dotted and your t’s are crossed.

If your company is seeking top accounting and finance talent, or you want to improve your accounting and finance hiring processes, contact the expert accounting and finance recruiters at Contemporary Staffing Solutions today.